Legendary fund manager Li Lu (whom Charlie Munger supported) once said, “The biggest risk in investing is not price volatility, but the possibility that you will suffer a permanent loss of capital.” So it can be obvious that you need to consider debt, when you think about how risky a given stock is because too much debt can sink a business. We notice that Ryerson Holding Company (NYSE: RYI) has debt on its balance sheet. But should shareholders be concerned about its use of debt?
When is debt dangerous?
Debts and other liabilities become risky for a business when it cannot easily meet these obligations, either with free cash flow or by raising capital at an attractive price. Ultimately, if the company cannot meet its legal debt repayment obligations, shareholders could walk away with nothing. However, a more common (but still costly) situation is where a company has to dilute its shareholders at a cheap share price just to get its debt under control. By replacing dilution, however, debt can be a very good tool for companies that need capital to invest in growth at high rates of return. The first step in examining a business’s debt levels is to consider its cash flow and debt together.
See our latest analysis for Ryerson Holding
How much debt is Ryerson Holding?
As you can see below, Ryerson Holding had debt of US $ 674.9 million in September 2021, up from US $ 818.6 million the year before. On the other hand, it has $ 39.9 million in cash, resulting in net debt of around $ 635.0 million.
How healthy is Ryerson Holding’s balance sheet?
The latest balance sheet data shows Ryerson Holding had $ 893.2 million in liabilities due within one year, and $ 1.12 billion in liabilities due thereafter. In compensation for these obligations, he had cash of US $ 39.9 million as well as receivables valued at US $ 717.8 million maturing within 12 months. It therefore has liabilities totaling US $ 1.25 billion more than its cash and short-term receivables combined.
Given that this deficit is actually greater than the company’s market cap of $ 959.9 million, we think shareholders should really watch Ryerson Holding’s debt levels, like a parent watching their child do. cycling for the first time. In the event that the company were to clean up its balance sheet quickly, it seems likely that shareholders would suffer significant dilution.
In order to measure a company’s debt relative to its profits, we calculate its net debt divided by its earnings before interest, taxes, depreciation and amortization (EBITDA) and its profit before interest and taxes (EBIT) divided by its interest. debtors (its interest coverage). In this way, we consider both the absolute amount of debt, as well as the interest rates paid on it.
Ryerson Holding has net debt of 1.8 times EBITDA, which isn’t too much, but its interest coverage looks a bit weak, with EBIT at just 5.3 times interest expense. While this doesn’t worry us too much, it does suggest that the interest payments are somewhat of a burden. Fortunately, Ryerson Holding is growing its EBIT faster than former Australian Prime Minister Bob Hawke, posting a 197% gain in the past twelve months. The balance sheet is clearly the area to focus on when analyzing debt. But it is future earnings, more than anything, that will determine Ryerson Holding’s ability to maintain a healthy balance sheet going forward. So if you are focused on the future you can check this out free report showing analysts’ earnings forecasts.
But our last consideration is also important, because a business cannot pay its debts with paper profits; he needs hard cash. We therefore always check how much of this EBIT is converted into free cash flow. Over the past three years, Ryerson Holding has recorded free cash flow of 71% of its EBIT, which is close to normal given that free cash flow excludes interest and taxes. This free cash flow puts the business in a good position to repay debt, if any.
Our point of view
When it comes to the balance sheet, the main positive for Ryerson Holding was the fact that it appears to be able to increase its EBIT with confidence. But the other factors we noted above weren’t so encouraging. In particular, the level of total liabilities gives us shivers. Looking at all of this data, we feel a little cautious about Ryerson Holding’s debt levels. While we understand that debt can improve returns on equity, we suggest shareholders watch their debt levels closely, lest they increase. The balance sheet is clearly the area to focus on when analyzing debt. However, not all investment risks lie on the balance sheet – far from it. We have identified 4 warning signs with Ryerson Holding (at least 3 which don’t suit us very well), and understanding them should be part of your investment process.
If, after all of this, you’re more interested in a fast-growing company with a strong balance sheet, take a quick look at our list of cash-flow net-growth stocks.
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This Simply Wall St article is general in nature. We provide commentary based on historical data and analyst forecasts using only unbiased methodology and our articles are not intended to be financial advice. It does not constitute a recommendation to buy or sell any stock and does not take into account your goals or your financial situation. Our aim is to bring you long-term, targeted analysis based on fundamental data. Note that our analysis may not take into account the latest announcements from price sensitive companies or qualitative documents. Simply Wall St has no position in any of the stocks mentioned.